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Powering Forward

Electric utilities stay focused on improving their operations and management to ensure that results for shareholders are sustainable.

Jonathan Arnold Deutsche Bank 212-250-3182 jonathan.arnold@db.com

Exelon (EXC) still expects $3-$6/megawatt hour of upside to power forwards by 2015-2016 from coal retirements, but are less certain on timing. While time will tell if the thesis plays out, the business plan and dividend are now positioned to weather the status quo.

We think investors should find comfort in the sustainability of the dividend under EXC’s stress cash scenarios, while those looking for an even more conservative approach likely aren’t invested in the power-levered EXC story to begin with. Looking forward, EXC intends to utilize its increased financial flexibility to refocus on regulated and/or contracted growth opportunities, or at a minimum pursue value-additive debt reduction.

Solid 2013 guidance looks stronger at ExGen, weaker at the utilities. Initial 2013 EPS guidance of $2.35-$2.65 and the cash flow outlook were slightly stronger than our forecasts. [We are] trimming [our] 2013-2014 estimates on higher cost assumptions. We are maintaining our 2013 EPS estimate of $2.45 while lowering 2014-15 by a nickel in each year to $2.20 and $2.35 on higher cost assumptions at ExGen. Our estimates embed modestly above-market power prices, but also haircut EXC’s retail/optimization margin outlook.

Our core thesis revolves around POM’s comparatively high EPS growth driven by a combination of an assumed improvement in regulatory treatment and planned rate-base growth. We project EPS will grow by 9-10% annually during the period 2013-2016 off the 2012 base of $1.17 (excluding a $0.04 early lease termination gain) …

[We] think EPS could materially improve in 2014 depending upon rate-case outcomes and that POM will grow into a more-reasonable payout ratio over time. We consider the current dividend to be secure and note that POM affirmed it on its conference call.

POM initiated 2013 guidance of $1.05-$1.20. We estimate that the range implies anywhere from $5 million to $40 million of net income benefit from 2013 regulatory outcomes. It also excludes cross-border lease EPS of $0.12.

Our 2013-2015 EPS estimates of $1.12, $1.35, and $1.50 reflect the aforementioned loss-lease EPS partially offset in 2014 and 2015 by lower new-equity needs. All things considered, it appears that POM has the ability to execute a reasonably graceful exit from the cross-border lease issue (depending upon the outcome of the planned liquidation).